Notes From Underground: Is It a Nehru or NAIRU?

Tomorrow begins the semi-annual testimony of the Fed chair before the illustrious houses of legislature of the United States. Janet Yellen will testify before the House Financial Services Committee tomorrow and the Senate Banking Committee Thursday. Chair Yellen will read the same prepared speech before each Committee and then each member of the Committee gets a preset allotted time to ask questions. (Please note, Yellen’s testimony will be released at 7:30am CST tomorrow.) The chair will dodge predictions but will put forward the most recent DOT PLOTS and FOMC statement as the backdrop to her testimony. THE MOST INTERESTING ASPECT WILL BE WHETHER OR NOT THE FED CHAIR SOFTLY CRITICIZES CONGRESS FOR NOT DOING MORE TO PUT FORWARD SOME TYPE OF FISCAL STIMULUS. Chuck Schumer may believe the FED is the only game in town but Chair Yellen will plead that the FOMC cannot be the sole stimulant to a moribund economy, especially with the headwinds blowing around the globe.

The FED will be under attack from the political left for raising interest rates even though wages have remained stagnant. The political right will ask about why the FOMC waited so long before removing the ZIRP. Also, pay close attention to Yellen’s answer to the inevitable question about the economy going to a NIRP (negative rate policy). The Fed chair will say that the employment growth has been strong and the recent unemployment rate of 4.9% is pushing against the non-accelerating inflation rate of unemployment (NAIRU), an indication that the theoretical closing of the OUTPUT GAP hints at a coming rise in wages and thus possible inflation pressure. My question about NAIRU: Is a domestic employment gap relevant to upward wage pressure when a billion Indians are beginning to join the global labor force? (Hence the NEHRU pun.)

The Chinese economic miracle unleashed a billion potential workers and put downward pressure on wages across the globe. With the INDIAN RUPEE trading at multi-decade lows, foreign direct investment will begin to push competitive Indian goods around the globe. The FED keeps its models on a domestic bias but as long as labor and capital flow are unimpeded around the world the influence of labor thresholds is severely diminished. Coupled with the flawed NAIRU measure, January’s Labor Market Conditions Index revealed some new softness in the 10 labor market indicators that Chair Yellen relies upon for a full picture analysis.

The current fragile financial situation around the globe, plus an uncertain wage situation in the U.S. will tilt Yellen toward the dovish side. She will not be in Stanley Fischer’s ballpark of four rate increases, but will play in a LEAGUE OF HER OWN. Again, Chair Yellen’s background is as an academic labor economist who has shown great concern for the stagnant wages of the middle class. The power of the NEHRU is greater than the academic theory of NAIRU.

***Yesterday, there was an article on Bloomberg’s First Word platform titled, “Yield Curves Don’t Have to Invert to Signal Recession,” in which the writer, Alexandra Harris, quotes BofA’s Ruslan Bikbov as theorizing that in a near-zero interest regime, the yield curve doesn’t need “… to flatten significantly for a recession to occur.” Bikbov is making a point that I have raised in the BLOG and with Rick Santelli many times. The FED and the central banks have broken the signaling mechanism of global bond markets, which is why volatility will increase as investors do not have a reliable tool in which to price risk. This was a great concern of FOMC member Jeremy Stein, who resigned from the FED and went back to teach at Harvard because he couldn’t prevail on this critical issue (my opinion). But I have noted that the yield curve still has importance as critical price levels are violated. All hell will break loose when we close under 115 basis points on the 2/10 curve.

Well the exaggeration was intentional as the renewed flattening in the curve has created greater market uncertainty and probably increased angst in the FOMC boardroom while the yield on the 10-YEAR TREASURY NOTE has declined more than 40 basis points since the December 16 rate increase. Yes, the 10-year note is responding to the global drop in yields, which should be very disconcerting to a domestic-oriented FED. Negative yields around the world are having a detrimental impact on the designs of the FED models. Today, the 2/10 curve settled at a an eight-year low and is closing in on 95.53 basis points last touched on January 2008.

The big difference from eight years ago was that the FED FUNDS RATE was at 4.25%, which gave the FED room to cut rates in response to signals provided by the yield curve. Today, the FED has very limited capacity to respond to a flattening yield curve. The lack of steepness in the YIELD CURVE is acting as a drag on bank profits, which raises the question about the FED removing the Interest on Excess Reserves (IOER), a profit center for the large banks. If the FED went to negative yields and if the curve did not react via steepening, bank profits would be squeezed.

***More duress in Europe as yields on Greek two-year notes climb to 15.5% as not all is going well in the Greek negotiations. It appears that the market is pricing in the Greeks departing from the EU and a Greek debt default. The Portuguese sovereign yields are also on the rise as the 10-year note approached 3.75%. All is not well in the European debt markets, but because of the ECB‘s active intervention the market is not able to price sovereign bonds accordingly. If the BIS were to ever push for a realistic risk weighting for sovereign debt many more European banks would be severely undercapitalized for bank regulations deem all sovereign debt to carry a zero risk weighting, which means there is no capital reserve required. This will continue to be on our radar. Maybe Chair Yellen will actually be asked about the stress and strains in the European capital markets and their impact on the U.S. financial system.

There are several potentially substantial legal and practical constraints to implementing a negative IOER rate regime, some of which would be binding at any IOER rate below zero, even a rate just slightly below zero,” the authors wrote. “Most notably, it is not at all clear that the Federal Reserve Act permits negative IOER rates, and more staff analysis would be needed to establish the Federal Reserve’s authority in this area.”

It appears there is a legal question on whether the Fed has legal authority to go to negative interest rates. This was from Bloomberg yesterday.

“The Federal Reserve may not have the legal authority to set negative interest rates in the U.S., according to a 2010 staff memo that was posted late last month on the central bank’s website.
The document, which is dated Aug. 5, 2010, and was publicly released on Jan. 29, suggests the law that authorized the Fed to pay interest on excess reserves, or IOER, may not grant it the authority to charge interest. That could constrain the central bank’s ability to take interest rates below zero, though it might be able to find a work-around.”

…

“There are several potentially substantial legal and practical constraints to implementing a negative IOER rate regime, some of which would be binding at any IOER rate below zero, even a rate just slightly below zero,” the authors wrote. “Most notably, it is not at all clear that the Federal Reserve Act permits negative IOER rates, and more staff analysis would be needed to establish the Federal Reserve’s authority in this area.”

Yra, Shouldn’t this issue be part of the narrative for the election? It seems to me that a simple,

“I would call on Chair Yellen to provide legal basis by 2/20/16, that the fed has the legal power to follow the rest of the herd to negative rates if deemed necessary”

would suffice to show that the candidate had a grip on the issue, that the fed were considering it, and by using the derogatory term “the herd show their disdain for the current initiative these loons are progressing.

Gentlemen,
Thanks for posting the Bloomberg link. I’m sure the question will come up now that it’s been raised in the press. My first thought was since when does a silly law get in the way of what the executive branch or any one of its appendages want? As with healthcare, any compliant court can step up and complete the destruction.

Yra,
Great post.
Your question re NAIRU points to evidence that the Fed has yet to take into account the dollar’s role as the reserve currency, only using domestic data for its “models” while capital and labor flows much easier throughout the globe. I know, the “dollar” is under Treasury’s purview, but in a Keynesian fiat world, I’m under the impression its supposed to be a sort of partnership.

More keen observations on the 2-10 curve and noting the difference between working with (or fixing) a 4.25% funds rate vs. 13-26 bps. The Fed has painted themselves into corner and is left playing with a pile of string.

Hey Joe
lots to think about in your post. Your “while capital and labor flows much easier throughout the globe” got me to considering what I am seeing right now. We train the best and brightest and they FLEE to the far corners of the world to be met by the same funders they would get here WITHOUT the government bollocks, also they are treated like heroes and heroines NOT social parasites. Read a report that basically says our innovation has all but disappeared.

Yra stated “..as labor and capital flow are unimpeded around the world the influence of labor thresholds is severely diminished.” I was agreeing and would also add that I haven’t heard a major economist or policy maker make the same correct observation. Goes to show that practical experience and viewpoints are no longer much valued by Access Journalism.

Once upon a time, before the U.S. federal government got into the welfare/entitlement business in 1965, if it needed cement masons, it allowed immigration of cement masons. One of the hang ups on immigration policy is agreeing on welcoming those that have something to contribute and restricting those that come for the various “rights” and entitlements our government and courts have declared. (Who I cynically believe a large part of the political class simply views as a future voting constituency.)

I understand many come here for an education. If it’s not publicly subsidized, I’d like to extend them any opportunity. But I also believe the U.S. is not the only place to get a good education. Maybe we’re the only ones that offer net subsidies? It’s been alleged that Obama took advantage of some of them.

Hey Joe
Yra makes an excellent point and thank you for highlighting it. My current hobby horse is that the definition of Labor has been changing dramatically over time. So, using your excellent example, masons came in and had a lifetime of employment as masons BUT today’s workers can expect to work in many fields and in a more adhoc manner. This goes to the whole concept that this generation will be a throwback to the immigrant model where they have no real concept of ownership, they rent not own. This ranges from Apps to apartments. To using Mooc’s ( like me) for education.

So if they lack the concept of permanence and they extend that to national identity what will that do to our tax base? Art Cashin today said that the fed would become data driven with 4 payrolls before June ( he is discounting March for hike) SO what data are they actually counting to make decisions.
I was initially dreading sitting in on a conference call from Washington until they broadcast this which I think comes to bear on my point. Using a Yra’ism “the times they are a changin..” I don’t really know what that means but it sounds apposite

There are countless changes that have taken place in productive areas of commerce, which I don’t think we’re measuring their total positive impact on growth. I used an example of a cement mason because I knew one who came over in steerage only to be turned back at Ellis Is and had to try again, successfully, 8 months later. The Wizard Of Oz in 1939 gave us a peak into the coming age of machines.

The opportunity to have varied careers is one of the better outcomes of change. Work and home life have drastically evolved over just a few decades. Some good, i.e more leisure, some not so good, i.e. 2 parents working to meet expenses, but trade offs are inevitable.

I’ll beg to differ a bit, if I’m reading you correctly, on immigrants and ‘ownership” society. Most of my forebears bought a house and/or business as soon as they saved enough. Pre WW 2 mortgages were pretty much something available to the merchant class on up, so working people had to actually save for a house.

But it was doable in those days. (A new house in Chicago’s Portage Park in early 40s was about $4500.00, but few had that much.) It looks like we’re headed back to that, (throwback) otherwise how can there be any existing homes to be bought with 30 yr fixed under 3.75%? Homebuilders should be backlogged out a year. Anyone on this blog can provide a well reasoned answer for that.

But renting rather than ownership, whether it be a home, business or anything else that’s amortized might not be choice but an only alternative. As to identity, I do believe policy needs to promote assimilation. That’s what immigrants did before 1970. of course it was easier for expat Brits. 🙂

The exact data the Fed uses is published but the methodology might throw me for a loop. Dot Plots? NAIRU? I think the Fed has gone all NON-GAAP on us. That’s why I always like to hear what Art Cashin has to say. Market talk you can make sense out of rather than the faculty lounge soliloquies we are subjected to thru Access Journalism.

Yra- Great piece! Japan would seem a good example of no inversion in the yield curve while experiencing a recession. I used to fight “the developing world is going Japanese” idea. But, the deeper we get into ZIRP and NIRP and with how policy makers and capital is acting, the comparison seems to get more apt. What does that look like if so much of the developed world falls into a lost decade or so? How does the many differences between the two scenarios affect the outcome? Can the CB’s really keep it under control and not have capital throw in the towel on cash and bonds and see a massive shift towards assets that can protect against cash as trash? Kuroda’s self described Peter Pan world where “the moment you doubt whether you can fly, you cease forever to be able to do it,” is very perplexing! For how long “the crowd” will believe we can fly (highly correlated with belief in Central Bank omnipotence) is as important and difficult a macro question there is IMO. Yield curves globally are not particularly joyful right now on global growth prospects, that is for sure.

rob–i was aon a cnbc closing bell in London with Wilbur Ross and we discussed this greek situation—anchor was the smart Louisa Borjenson –and he was opining on th efficacy of the Troika bailout and i was not buying it –but he was coming off his success in Ireland and pretty cocksure—but Greece was sold out by Alexis Tsipras as he drank from the poison chalice provided by the plutocrats in Brussels—-the Greek people are suffering terribly and Greek two year notes are still 15%—-really a sound financial bailout

Hey Joe
this blog format seems to cap the discussion depth to 3 which is great BUT I would like to carry on for one more round if Yra would permit me.

“old labor brain trust.”
Strangely enough Secretary Rubin was on the board of a startup I was involved in. He always seems to get what I was saying where the others had problems breaking the mold. I think you might want to watch the whole thing just in case you change your mind. They are talking about interesting things and I would welcome your opinion as to whether they are Labor thought crime types ( see what I did there 2 + 2 = 5 :-))

What I meant by the immigrant model was the first generation could not own IMMEDIATELY but saved to put down the deposit on a home for the subsequent generations. This is what we did.

I meant no insult as I am an immigrant myself. We came to America in 1995 with $5000 and four suitcases, today we own outright a multi apartment building in Central Chicago, we have our own money that we manage trading options/futures and try to contribute back to the society we love by helping the next generation of immigrants. Right now we are looking to build the next generation app, the sand hill guys like the narrative title

“we can remember it for you wholesale” Phillip K Dick

SO here is a NEW model for the next generation, get your asses down to the library and take out a book on Programming in Python. Next go to Amazon and buy a Raspberry Pi starter kit. If you learn how to program with the minimum available resources I “think” it will make you a better developer.

Set your self some fun projects you think you would enjoy, I would concentrate a little on financial apps using Python and the representation of complex data sets (HINT). Next start turning up to Meetup groups that concentrate on finance ( the hedgies are NOT stupid) and show your projects off. If you get the opportunity become a contractor not an employee, it’s more exciting and more in keeping with what I think is the American spirit. If you get a contract with them save 50% of your NET and use options provide you with extra interest whilst planning for the future. DO NOT lose sight of the real goal here which is to start your own business! We need diversity not homogeneity. Diversity breeds conflict and conflict breeds progress ( sadly war pushes us forward faster than peace) the more competition there is out there the faster we move.

Congratulations on your success and accomplishments since emigrating. Invite your like minded friends. Whatever you and yours decide to do with it is fine by me. I’m not so sure Illinois’ political class appreciates it. You didn’t build that, you know.

Bob Rubin’s footprint is much bigger than the Hamilton Project or a single board seat. Bill Clinton, too, has raised money for charitable causes and supposedly good ‘works.” Nonetheless, I’m not a fan of either. The reasons are purely political and where Rubin is concerned it has much to do with the defamation of the Swiss in the 90s.

I’d rather not use this blog to express what I really think of Clinton-Rubin, Inc. From my perspective I wouldn’t mind seeing Lew Lehrman as Fed chair, and the last really good Treasury Sec the US had was Bill Simon. A real Wall St. capitalist when there were still capitalists on Wall St. Rubin fits the mold of a true Statist. He certainly wasn’t a model statesman while at Citi in the 2008 bust. Did he ever offer anything constructive? Or was he simply deferring to his colleague Hank Paulson who was a jock at Dartmouth and kissed the right rings? Enough of that.

As for Labor thought crimes, I don’t quite follow. It’s a lot easier to express an opinion on anything today, and that’s a good thing. Blue Ribbon panels, symposiums, etc, are fine but usually over think a problem or create bigger ones especially if they have the backing of the police power. I.e Vision Zero urban transportation planning.

The last part of your comment is the way to go to innovate. The WSJ recently had an article on today’s parents encouraging the kiddies to code before they recite nursery rhymes. Intellectual conflict breeds good, potentially productive ideas. It sure trumps today’s GroupThink which permeates academia today. I don’t believe I have much substance to add. BTW, I was out looking at some of the new hardware available today. Simply amazing how far we’ve come since Bell Labs in 1948.

I wholly share your sentiment on war and peace, although the next go around may find it much harder and costlier to use whatever it is we develop for advancement.

Hey Joe
great I didn’t want to seem anti immigrant as, to me, the ones who contribute are the life blood of this wonderful country. When I first came here I was sentenced to have to attend something called the Executive’s Club of Chicago. I got put on a committee and got ripped a new one by one of the members because I was being WAY WAY too cocky. I figured out he was completely right and he agreed to be my native guide in America ( he’s a player in the Cato institute I believe) ANYWAY he gave me a copy of the constitution ( a very old one of his) AND in return made me promise to go somewhere quiet every year to read ALOUD two passages. “the desolate wilderness” and “and the fair land.” to constantly remind myself of why America ended up the way it did. I keep my promises and it works. SO when I talk about Sec Rubin all I can refer to is my experience. In those days my role was to come up with innovations in the financial technical arena for the global banks.

As to the labor thought crime issue I was referring to Larry Summers ( who I like alot ) taking on the lads at MIT in the panel discussion, I would suggest you watch it as he makes some excellent points, at least I think so. As to blue ribbon things I was on several quango’s and it all depends on the level to which the members consider they have to protect their reputation, a good one ( in my experience) tends to be where someone wants to cause conflict and actually does it.
teaching kids to code is one thing BUT giving them the framework to become skilled at it is another. Books have a tendancy to have some level of credibility as any buffoon can make a youtube video. The raspberry pi project ( starts with a $5 REAL computer and goes up to $100 for the full kit so NO EXCUSES!!!) was started ( by Cambridge uni) to fill in the skill gap caused by script kiddy education at school. They were turning up to Cambridge being able to build fraking excellent web pages but no clue how to code. The Cambridge guys took action and boy did it work.

I don’t want to hog Yra’s blog any more but I have enjoyed this discussion. Thank you for your thoughts.

Kyle Bass: “What we are witnessing is the resettling of the largest macro imbalance the world has ever seen,” he wrote. “Credit in China has reached its near-term limit, and the Chinese banking system will experience a loss cycle that will have profound implications for the rest of the world.”